Fannie Mae, Freddie Mac, and the Destructive Power of Politically Correct Intentions

A first-rate essay at Philanthropy Daily reports on a book from New York Times reporter Gretchen Morgensen and housing finance expert Joshua Rosner, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon. Although it comes with immaculate center-left credentials, it places the blame for the cratering of the housing market — and the great American financial collapse of 2008 — squarely on the ideology of structural racism and the way in which this was leveraged to justify abandoning responsible lending standards in favor of politically correct measures to increase minority homeowner rates.

When then Secretary of Housing and Urban Development (now Governor of New York) Andrew Cuomo launched “new and aggressive affordable housing goals for Fannie and Freddie” in 1999, he predicted it would “help reduce the huge homeownership gap dividing whites from minorities.” President Clinton was pleased. Morgenson and Rosner write:

Regulators were relaxing rules, Fannie and Freddie were inflating their portfolios, homebuilders and subprime lenders were flexing their muscles too. To meet the goals Fannie and Freddie had to buy riskier mortgages, such as those defined as subprime.

Some $160 billion in subprime loans would be underwritten in 1999, up from $40 billion five years earlier. And in another four years, that figure would jump to $332 billion. Many of those loans wound up in Fannie’s and Freddie’s portfolios. By 2008, some $1.6 trillion of toxic mortgages, or almost half of those that were written, were purchased or guaranteed by Fannie and Freddie.

The essentials of the story, says Scott Walter, are “oceans of tax dollars flowing to private groups – for-profit and nonprofit – that are praised by politicians who want credit for the subsidized housing boom, with the whole party lubricated by the dissolving of traditional lending practices, which in turn is justified by claims that unfettered lending will remedy racial disparities in housing.” Advocates of “structural racism” cite those disparities as evidence of systematic discrimination against minorities, and Fannie and Freddie were given a new charter, new powers, and so further distorted the housing market by innoculating banks against the risks of reckless lending practices when they were lending to minorities. It’s the law of unintended consequences at its most thoroughly destructive.

ACORN — the Association of Community Organizations for Reform Now, a key ally for Fannie/Freddie, the Democratic party, and, as it happens, Barack Obama — was instrumental in helping the federal government draw up the blueprints for its social engineering. A later-discredited study from the Boston Fed fueled the rage of accusing the housing industry of endemic racism, and became more reason to expand Fannie/Freddie power. Then, as the power of government expands, so do the opportunities for corruption with organizations like ACORN and politicians who enjoy sweetheart mortgage deals, bottomless pits of campaign cash and the aura of social justice.

[A]s Congress mulled over the company’s future, Fannie Mae began making significant grants, hundreds of thousands of dollars each, to consumer and community groups favoring increases in low-income housing. The groups, such as the Association of Community Organizations for Reform Now, or ACORN, had been agitating for tighter regulations on Fannie Mae. But after receiving the grants, ACORN and most of the other groups changed their tunes.

James Johnson established a massive slush fund to curry favor with politicians like Barney Frank, community organizations like ACORN and special interest groups like the National Council of La Raza, and then leveraged all of them to continue expanding their charter for more and more lending at greater and greater risk, all of which led to hundreds of millions of dollars in bonuses for James Johnson. So Morgenson and Rosner:

Even nonpolitical neighborhood groups funded by the Fannie Mae Foundation helped the company play its power game. When a nonprofit applied for funding from the foundation, it had to supply a list of political contacts within their area or organization. These contacts gave Fannie Mae a roster of influence that grew to four thousand names at its peak.

The army of partisans was called to arms whenever someone in Congress had the audacity to suggest that Fannie and Freddie ought to reduce the size of its exposure — and thus you ended up with people like Barney Frank denying that there was any problem at all, right up to the point where the whole system imploded.

Listen, I’m not saying there were no other contributors, even major contributors on both sides of the aisle, to the housing collapse and the ensuing financial crisis. There were. But it’s not hard to understand how (1) chartering the government-sponsored entities and encouraging the banks to walk further and further down the plank of subprime home loans, while (2) insulating them from the dangers of their risky lending practices by purchasing the subprime loans and backing up the loans with implicit promises was just a recipe for disaster. Ultimately the scheme exploded and did incalculable harm to those it was meant to help. As Walter writes, the “villians” of both parties “enriched themselves, while bringing far more hardship to the poor and minority Americans whose struggles were used to justify the scams.” Now, in the midst of the financial crisis, African-American and Hispanic-American households are arguably worse off than they have ever bee

The expansion of opportunities for corruption, and the extraordinary harm caused by unintended consequences, explains as eloquently as possible the dangers of a large and ever-expanding government. These are not abstract concerns. The African-American community stands decimated, in part, because of the exploitation of honorable intentions.

“To give every American a stake in the promise and future of our country, we will bring the highest standards to our schools and build an ownership society. We will widen the ownership of homes and businesses, retirement savings and health insurance, preparing our people for the challenges of life in a free society.”

Timothy Dalrymple

Are you assuming that I’m going to defend Bush on this point? -Tim

John Haas

Of course not. Just illustrating your point about how widespread this was.

http://www.theproblemwithkevin.com kevin s.

George W. Bush eagerly touted the increase in minority home ownership. That is correct. This is where compassionate conservatism gets you.

One thing on deregulation. When you selectively deregulate facets of an industry, that is effectively the same as regulating. When the government picks winners and losers, it skews the market accordingly. It’s a different method, but the destructive power is the same.

Chris B. Behrens

At the outset of all of that, a wise leader would have said, “I don’t know…this system is a very complicated one, and the consequences of interfering with it are unclear. Maybe we should work on getting people able to afford the houses rather than undermining this much more complex mechanism.”

http://www.theproblemwithkevin.com kevin s.

If Ron Paul adopted “maybe we shouldn’t” as his campaign slogan, I might caucus on his behalf.

John Haas

Chris, if you recall back to when the discussions preceding this policy were occurring, there was much talk about “stakeholding,” and the effects it would have on earners/families in the way of enhancing their responsibility, earnings, etc. In hind-sight, of course, everything looks clear and obvious, but there was a belief that home-owning (in conjunction with what was then–the 1990s–a relatively healthy economy) would, in fact, make the families who owned them more likely to afford them.

Whether that idea has been entirely discredited is a question. Constructing such an initiative around adjustable rate mortgages was one choice–not inherent in the very idea of the benefits of “stakeholding”–which had, obviously, a large role in the mortgage crisis.

The housing bubble–in part the result of immense amounts of foreign investment capital combined with unregulated speculation on mortgage-backed securities–was another. But hey! That’s your free market at work!

Kevin s.

That’s not at all the free market at work. The market was intentionally distorted, bringing unqualified buyers into the market. There was also a lot of fraud.

John Haas

Thanks for that observation, Kevin with a capital K. My description of a “free market at work,” however, applied to “foreign investment capital” and “unregulated speculation on mortgage-backed securities.”

You can’t point to specific actions within a manipulated market and say they are examples of the “free market at work”. The housing bubble was exacerbated by governmental guarantees, as well as fraud.

John Haas

OK, I think I see your point, kevin. Mine was tomerely identify these as a) important elements in the mix (ie, it wasn’t all manipulation and fraud–there were these elements working, too, pretty much as the proponents of capitalism and deregulated speculation intended them to); and b) that these are “free-market” type elements–they’re not socialism, or big government regulations, or liberal do-gooderism.

How they would have worked and what the consequences would have been without the other elements is unknowable in any detail. But in this case, what they did do was drive the housing bubble, which made the holders of subprime mortgages all the more likely to default (because the price was so high), and all the more damaging when they did.

J Sebastian

So you think that the “free market at work” would have functioned exactly the same way with regards to rampant speculation on MBS products had the govt not been backing these toxic loans? You do understand that the entire pyramid of derivatives teetered on loans mandated, secured, and brokered by the GSEs? How you can blame free market actions for something that existed only because of nanny-state, do-gooder meddling is beyond me.

Jerry

The same conclusion was reached by Thomas Sowell in his book The Housig Boom and Bust.